Tuesday, July 10, 2012

This chart adds to my comments yesterday about reading the market tea leaves. The chart is Bloomberg's calculation of "financial conditions" and it uses the Vix index and swap spreads—two of my favorites—as key ingredients. What it is saying now is that financial conditions are very close to "normal." That's remarkable, given the raging concerns across the pond over the possible default of major countries and the possible collapse of one of the world's major currencies.

This next chart compares the Bloomberg Financial Conditions Index (white line) to the S&P 500 index (orange line). Note that the two move almost in lockstep, with a correlation of 0.94. What that tells me is that even though the economy is muddling along at a 2% growth rate, as long as financial conditions don't deteriorate, there is upward pressure on the prices of risk assets. We see the same relationship between the Vix and the S&P.

Tranquil conditions at the very least serve to nudge investors in the direction of yield, which in the case of the S&P 500 is substantial: the earnings yield on the S&P 500 is currently over 7%, and earnings have grown 11% over the past year. The world simply can't pass up positive yields if conditions don't deteriorate. Which is another way of saying that the market is priced to some very pessimistic assumptions; if those assumptions aren't confirmed by reality, then risk asset prices are likely to rise.

Economic Co-operation and Development (OECD) Composite Leading Indicators (CLIs)

"09/07/2012 - Composite leading indicators (CLIs), designed to anticipate turning points in economic activity relative to trend, point to an easing of economic activity in most major OECD economies and a more marked slowdown in most major non-OECD economies.

The CLIs for Japan, the United States and Russia remain above long term trend but continue to point to dissipating momentum, especially in the case of Russia.

July 10 (Bloomberg) -- Lakshman Achuthan talks about the performance of the U.S. economy. Achuthan speaks with Tom Keene and Sara Eisen on Bloomberg Television's "Surveillance."

“It is not our definition. It is the definition of what a business cycle is, which was established by my mentor Jeffrey Moore’s mentor Wesley Mitchell back in the 1920s. What is a recession? It is not a statistic; it is a process between production, employment, income and sales. When you look at those four measures, they are rolling over.”

“It is not all about GDP. It is about jobs. It is about income and sales. A recession is a vicious interplay among output input employment, income and sales. When you look at 2001, you can’t find two negative quarters in a row, yet you lost 3 million jobs. Or half the value of the NASDAQ. How are you going to tell someone that wasn’t a recession?

When you look at the data today, you see that industrial production is off of its April high. Manufacturing and trade sales, much broader than retail sales, is off its December high. Real personal income growth, which does not always go negative during a recession, has been negative for several months so it is consistent with a recession having already started.”

no price/index/metric is knowable as to real value in the face of monolithic monetary policy across the globe. at some point the monetary policy will return to being neutral and then we can evaluate values.

Please, I beg you to talk to someone with financial quant background, not another self-proclaimed economic pundit, about how to correctly calculate correlation. For two independent financial time series, it's close to impossible to get 94% correlation. Correlation for stocks should be on returns, not prices! That's statistics 101.

The Lakshman Achuthan interview was very intersting. He is now saying that the economy "feels like it's in recession" whereas he said last year that the economy was about to collapse Q1, latest Q2 and that the unemployment rate would go up substantially. He's now using whatever definition of a recesssion suits him to say his call was correct.